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I would characterize biotech "bets" as educated gambling, as it is with investing in companies without cash flow, including high-growth technology companies. For biotech, focus on the indication/pipeline progress (is it a phase I or II product?), competitive landscape, and most importantly, clinical data. Is the drug using a new and unique MOA or is it a me-too drug that is easy to replicate? These are some of the questions you have to ask yourself when you're analyzing the data.
Or you can just follow the hot money and invest into the gene-editing and mRNA hype. You have to know when to get out though if the market dries up, as it did with NASH and antibiotic drugs more recently, given data/or sales have been disappointing for those 2 markets.
Thanks for the insights. I'm completely new to the field so apologies if these follow ups are completely basic.
What does MOA stand for and who are the hot money in the early stage biotech investing?
Have you had any luck in these bets?
MOA = mechanism of action. Hot money is dependent on which technology seems to have the most potential to investors in the L-T.
I've had my fair share of wins/losses in biotech, but if you're new to the industry, I'd suggest staying away or investing in larger blue-chip biotech with cash flow, such as REGN, ALXN, BIIB, and etc.
Educated gambling requires education.
Do you have any experience or specific knowledge in/of the biotech industry?
Not really, I'm working in broader HC research role but we don't focus on these pre-revenue type companies.
Pull up BioPharmCatalyst.Com, look for PDUFA/Stage 3, and throw a dart. Most of these will have run-up by the time the catalyst comes around. Sometimes the stock can run up to the catalyst, positive news comes out, then just sells off. No edge what so ever.
Options prices on both sides deflate after, loses for everyone who played directional.
This is going to be a long-shot but is your bio picks attending any of the conferences that are coming up in the next few months (JPM has one in January)? They usually present key data. Check out the Advisory Committee Meetings as well.
I would also add I'm not biotech/pharm saavy, and this may seem super general but my initial thoughts are; check out the drug your pick is trying to get approval for, how big of a demand that market has, and have other companies failed with it in the past. Pretty much what bulugawhale said. With the company having no revenue, I'm assuming it's still in phase 1 where most of these fall out.
I've invested personally into options on early stage biotech companies around catalysts, but would not recommend it except for specific circumstances (and having a good understanding of options and the underlying stock's fundamentals), and considered doing so professionally but chose not.
The options markets (at least as of 2 years ago when I looked into this) for many small mid cap clinical stage biotech companies is incredibly thin. Many of the stocks are hard to borrow so shorting is expensive, and the bid / ask spreads on these options are crazy. It is almost impossible to get filled at a reasonable price
There are some situations where you can do some more complex option strategies where vol or time premium / theta is so mispriced that you can get a reasonable position filled. For example, often there is a big spike in expected vol before a clinical readout, and then expected vol is much lower after the readout. This assumes a discrete binary outcome from the clinical readout. However in practice clinical readouts can have significant ambiguity and volatility remains high for a while after the readout while investors digest the news
I used to be in biotech VC / hedge funds and have done a lot of PA investing into biotech as well.
If you aren't familiar with biotech, then treat it much like you'd treat bitcoin: only invest as much as you can afford to lose, and buckle up for a crazy ride. You are right that most traditional valuation methods don't apply to pre-rev biotech companies, it is a totally different world. But you can make (or lose!) a lot in a short time.
The only strategy I would hesitantly recommend for non-biotech people is this:
find a company that 1) has a clinical read out in 3-6 months and 2) has a "tech value" (basically enterprise value, or equity - cash assuming no debt) of ideally under $50M and potentially under $100M if it is a Phase 2 or 3 company (this is your "margin of safety", which you'll need if you don't have a lot of experience w biotech). These days VC Series A investments into preclinical startups value companies at $50-100M, and if Phase 1 or Phase 1/2 data looks good the value steps up significantly ($300M-1B+ enterprise value for Phase 1 or 2 company isn't uncommon if the product is good). So if you get a Phase 2 or 3 asset for $100M, it's a decent deal even if it's not the best asset
make sure the company has enough cash to get to the clinical readout
try to do a little research to determine whether the drug would be valuable if it worked (read the investor presentation, try to talk to one or two doctors or scientists in the relevant field)
a few weeks before the trial readout, the stock will often rise, as many people screen for near term milestones. sell before the data reads out
This strategy is basically buying dirty cigarette butts with one last puff, and assuming other investors think there is are at least two puffs and maybe even that it's a full pack of smokes. It worked reasonably well for me a few years ago, although the market is so hot now that few of these opportunities exist.
Sesen Bio (formerly Eleven Bio) is a good recent example. Stock tripled in a month on no news in anticipation of a study readout, and the study was meh, so stock gradually traded down
If you are serious about learning about biotech investing, it's basically about 3 things: 1) what is the unmet need for the drug (ie are patients basically dying without it), 2) will it work and 3) will it work better than anything else, at least for a subset of really sick patients.
For 1), you can get a lot of that online just googling around or even in investor presentations. But you want to talk to physicians to understand unmet need more deeply (that's what institutional investors do).
For 2), you have to dig into the clinical, and sometimes preclinical data, and understand biologically how the drug works. This really requires some expertise to be done right, though you don't need a phd. Basically predict the probability that the drug succeeds in the study. This is an imperfect science but my approach is figure out the value if it succeeds and if it fails, then look at what the market is saying in terms of implied probability of success, and see how strongly you agree / disagree with that -- if the market says 85% chance of success and you think it's below 50%, don't invest (don't short tho, too expensive and not worth it in this market). If the market says 10% and you think 1/3 or higher, buy
For 3), again you need to read data and talk to docs
Thank you for the great response. Could you elaborate a little bit on how you would assess the market's view on the probability of success?
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